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Reconstruction in lieu of repairs

A great deal of confusion has been created over whether repairs
will be allowed as a deduction or if it will be capital in nature. Section
11(d) of the Income Tax Act will allow a deduction from income if the expense
were for repairs made to property necessary for the production of income.

The word "repair” is however not defined in the Act. In this
instance is it necessary to look at case law and the dictionary. The Shorter
Oxford English Dictionary defines a repair as: Restoration of some material thing or structure by renewal of
decayed or worn-out parts, by fixing what has become loose or detached. The
Special Courts for Hearing Income Tax Appeals also has numerous principles for
defining "repairs”. A repair is the
renewal or replacement of a subsidiary part of a whole structure. It is not
necessary for the new materials used to repair property to be the same as the
old materials. It is important to distinguish between repairs and improvements.
This is where the tricky part starts. The test will be whether a new asset has
been created resulting in better income-earning capacity or if the asset is
restored to its original state. A great number of court cases are available to
help resolve this problem.

In the Rhodesia Railways Ltd v Collector of Income Tax case, they
repaired a railway track between Vryburg and Bulawayo. The railway track was in
a dangerous state through general wear and tear. A renewal project was created
to lay new sleepers, rails and fastenings over part of the track. It was
concluded that it was necessary to renew the track to its original state and
not the creation of a new asset, thus the costs incurred were constituted as
expenditure. In the ITC 264 case, the owner replaced the drainage system of a
property. The court held that the new drainage system did not increase the
property’s value and it was accordingly classified as a deduction.

In another ITC case, the owner replaced the brickwork façade of a
commercial building with new façade of a different material. The building
deteriorated through general wear and tear to a point of compulsory renewal.
The court determined that the new materials were used for practical reasons and
that the building’s income-earnings capabilities did not increase. Thus, the
costs incurred for the repairs were deductible.

In ITC 822, a manufacturing company had to replace a boiler that
formed part of a factory plant. Upon removal, parts of the roof and roofing
supports also needed to be removed. The court held that this was not a repair
and the expenses should be capitalised.

Therefore, if an asset or part of the original structure
deteriorated, got damaged or needed to be restored; it will be defined as a
repair. Any construction on an asset in addition to its original form will
constitute an improvement. It is important to assess each scenario on its own
merits to distinguish between whether the repairs were for improvements/reconstruction
or for restoring it to its original state.

Occupied for
the purpose of earning income

It should be noted that repairs will not be deductible if it was
not for the production of income. In the ITC 163 case, a taxpayer expended a
substantial amount on repairs prior to letting his premises out. Since the
repairs were a necessity for the lease agreement, the court ruled it as
deductible expenditure due to the fact that it was incurred in the production
of income In the case of Strong and Co of Ramsey Ltd v Woodified, the taxpayer
rented a vacant premise to prevent it from being occupied by competitors. After
making repairs to the property, the court determined that it was not for the
production of income and will not be deductible.

The sequence of events that lead to a necessary repair or renewal
is not important. In practice, the South African Revenue Service permits the
deduction of amounts expended to repair storm damage to a business premises.
The Commissioner may consider whether a repair/renovation constitutes a
reconstruction or not, and if it is, the expenditure will then be of a capital
nature.

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